Each week in my weekly newsletter EPIC Insights I attempt to create an analogy that will introduce a new idea and frame it in the proper perspective. The goal is to introduce the reader to my thought process so he can understand how I came up with the idea and then decide if he would like to replicate the trade. This approach is particularly useful if I am introducing a new type of trade or describing a shift in my point of view. However, for this week's technical trade, no such preface is needed.
Dryships (DRYS) is a company well known to nearly every active investor. A bulk shipping company that operates most of its fleet in the spot market, the company offers exposure to worldwide growth that is driven by China's need to acquire raw materials. For years, the stock remained below $20 until the commodity bubble drove an increase in shipping rates that vaulted the stock to above $130 in October 2007. From there, a series of failed rallies finally gave way to a collapse that drove the shares below $3 (a 98% loss) by March 2009.
Typically, companies do not experience such sharp declines in price and remain in business. However, DRYS is alive and well. A series of shares issuances has allowed the company to restructure its heavy debt load and continue operating. With shipping rates well above their bottom, DRYS remains viable.
When creating technical trades, we look for repeatable events that will offer predictive value. With such great volatility, DRYS has exhibited numerous trading patterns. Focusing on a year-to-date chart I see a pattern that offers tremendous potential-reversals.
A top reversal occurs when a stock is in an existing uptrend, opens above the prior day's closing price, and then closes lower on the day. Conversely, a bottom reversal involves an existing downtrend with the stock opening lower than the prior day's closing price and then finishing higher on the day.
Since January, DRYS has shown a number of top and bottom reversals. Each time one occurred, the price moved dramatically and provided great gains to those positioned correctly. With another reversal having taken place recently, we have a chance to mimic the prior gains.
Specifically, two top reversals (red circles) have occurred since January. The first (point 1) drove the stock from $16 to its March low of $2.79 (an 83% move). The second (point 3) took the stock from a recent high of $11.50 to below $5 (a 57% move).
The bottom reversals (blue circles) have been equally dramatic. A reversal after the March low (point 3) saw the stock move from $3.50 to $11 in two months (a 214% rally). After a reversal on August 27 (point 4), when the shares traded as low as $5.57, the stock has rallied 21% over the past 10 days. I expect much larger gains to quickly follow.
This history of sharp moves off of reversals encourages me to buy DRYS. Add in additional factors and the story becomes more compelling. Looking at the chart, we see the 200-day moving average (MA) sits at $6.92 and long-term resistance stands at $7. With my timing model flashing a buy signal and the shares quickly approaching each price point, we should see a rally through the MA and resistance. When that occurs, expect a strong rally that quickly runs toward $11 (black box) over the coming weeks.
For investors, DRYS carries great rewards, but high risks as well. Knowing this we must carefully tailor our trading strategy. Initially, I recommend a 1% position in DRYS as this week's technical trade. If the shares close above $7.50, buy an additional 2% position. Close the entire position if the stock trades below $5.65.
Note: At the time of this article, I am long DRYS.